The modern economic system came into
existence in July 1944, when representatives of 44 Allied countries convened in
Bretton Woods, New Hampshire. The result of that meeting was a system of rules
and institutions called the Bretton Woods Agreements that encouraged free
trade.
Among other achievements, Bretton Woods
set up the World Bank and the International Monetary Fund. The purpose of the
agreements was to prevent a worldwide economic collapse. During the Depression
of the 1930s, many countries had devalued their currencies to make their
exports more competitive on world markets, which created deflation.
As prices fell, companies had to lower
their payrolls, so unemployment soared. With millions of people out of work,
demand for products plummeted, causing more deflation, more unemployment, and
so on, in a vicious circle.
Under Bretton Woods, each country had to
tie its currency to the gold standard. The U.S. agreed to fix the dollar to
gold at $35 per ounce, which allowed foreign governments to exchange dollars
for gold. This had the effect of making the U.S. dollar the international
currency, and it helped to ease worries that national currencies would be
abruptly depreciated or that exchange rates would fluctuate randomly. (In
1971, the U.S. dropped the gold standard, and the dollar officially became the
“reserve currency” for the Western world.)
The U.S. was clearly the most powerful
member of the Bretton Woods alliance. Its economy and infrastructure had
actually become stronger during World War II, unlike the countries in Europe
that had been devastated by the war. Through Bretton Woods, the U.S. ensured
that there would be a ready world market for its products once the war ended.
Bretton Woods strengthened the world
economy by linking it to the strength of the U.S. economy. However, the credit
crisis in September 2008 revealed that when the U.S. economy faces a crisis,
the entire world is thrown into turmoil.
This is a radical departure from the
impact of crises in the economies of other nations. Problems in the economies
of Japan and East Asia in the 1990s were largely isolated in those countries.
That’s not the case with the current situation.
In fact, because of decreased demand for
its exports from the U.S., China’s economy is facing a period of slow...
